Private investment: Wait from intent to realisation

The disaggregated national accounts for FY23 have revived concerns about the longstanding deficit in private investment. The update showed that private gross fixed capital formation (GFCF), which measures new fixed assets created by financial and non-financial corporations, was 10.9% of the Gross Domestic Product (GDP) in nominal measures, marking a 90-basis points increase since the pandemic (FY21) and equal to the post-global financial crisis trend of 11%. However, it remains below the 11.7-11.8% range in 2012-14, and much lower than its 16.8% peak in FY08. GFCF solely by non-financial corporations also averaged ~10.7% in the past decade. These declines match the broader global trend of decline in private capital formation after 2008-09, a major factor for slower world growth in the period.

It’s important to flag that the decline in India’s business investments primarily originates from that in manufacturing, where the share of private capital formation in the GDP fell from 4.6% to 3.2% over FY12 to FY19, virtually stagnating thereafter. A marginal increase to 3.4% in FY23 perpetuates the pre-pandemic trend. Further, the fall in manufacturing private capital formation is primarily attributable to reduced investments in machinery and equipment, the biggest sign of manufacturing capacity addition. Illustratively, the proportion of such investments by non-financial corporations (the biggest share is from manufacturing companies) dropped sharply from 57.5% of the total in FY12 to 36% in FY20. Fresh creation of machinery and equipment assets has been broadly inactive, at 39% in recent years.

There are other features that are not widely noticed. For example, throughout the period of decline, the ratio of envisaged capital expenditure, as assessed from credit sanctioned by banks and major financial institutions, and actual GFCF measures from the national accounts, has systematically fallen. Last August, a study in the Reserve Bank of India (RBI) bulletin underlined this significant decline in the fraction of intended capital spending maturing into actual fixed assets addition — the long-term average over 1971-72 to 2010-11 for envisaged private capex that converted into actual investment (GFCF) of about 40.5% dropped to 15.3% in the decade to 2021-22. This was also half the 33% average in the decade preceding the 2008-09 crisis.

RBI regularly collects information on project finance data of private corporations from the major banks and financial institutions (along with equity issuances, and foreign borrowings in later years) to assess the short-term investment outlook on an annual basis. The near-term outlook shared last year flagged the rise in the value of total funded projects to ₹2.6 trillion in FY23 ( ₹3.5 trillion if other sources are included), the highest since 2014-15; at 1.3% of the GDP last year, this was nearly 1.8 times above that in FY22. In the longer-term perspective though, this intended private capex is 15% lower than it would have been if the pre-pandemic, five-year average growth in such funded projects (14.8%) had been maintained. Moreover, with only about ~10% of this potentially converting into actual capital formation in the last six years, there is likely a case for adjusting expectations. It is not as though investment financing has shifted to alternate sources, at least from 2007-08, when about 21.4% of the intended capex was converted to actual fixed assets. During this period, banks financed nearly 50% of the commercial economic activity; foreign direct investment and corporate bond financing averaged 16% and 9%, respectively. There is, however, no strict match between the two data sets. This is merely illustrative in order to understand if the weakening trend in conversion can be ascribed to substitution of financing from other sources.

Centre for Monitoring Indian Economy’s project announcements data, which too isn’t strictly comparable, also indicates the same tendencies. In 2023, for example, private project announcements surged to ~85% of overall announcements, but if we note that only ~12% reached completion, then again optimism must be tempered, and expectations lowered. In fact, firms’ forecasts regarding future economic conditions often appear overly optimistic, and misaligned with actual market realities, as observed from the systematic widening of the gap between current business conditions and future expectations since 2012-13 in RBI’s bi-monthly survey-based Business Expectations Index (BEI). For the last one decade, firms’ assessments and expectations are predominantly driven by profit margins and exports, which proxy external demand; they are consistent with observed patterns in manufacturing sector investments and global growth in the same period. Changes in capacity utilisation are another important driver of fluctuations in business expectations; this resonates with the growing slack in manufacturing capacities in the period.

The trend seems to be that while optimism fuels initial investment announcements, it frequently fails to overcome practical challenges. Possibly, the latter may be posed by an erratic growth pattern or cycle, external market conditions, or other factors, leading to many projects unrealised. What is pertinent here is that the numerous policy interventions from redressing policy uncertainties and stalled projects more than a decade ago to bad loans resolution, banks’ strengthening and consolidation thereafter, to a host structural reforms like the GST, the Insolvency and Bankruptcy Code, simpler business, improved labour legislation, and enhanced flexibility, formalisation, and digitalisation have altogether not succeeded in moving the needle from optimism and intentions to actual business investments.

What will move the needle therefore in this leg, or bridge the gap in intended and real, may be demand strength and its endurance. Clearly, the post-2008-09 growth rates are insufficient.

Renu Kohli and Kritima Bhapta are with the Centre for Social and Economic Progress. The views expressed are personal